Deferring, minimizing, or avoiding estate taxes altogether is often an important estate planning goal for married couples. However, uncertainty surrounding what the estate tax laws and the value of their accounts and property will be at the first spouse's death can leave a couple feeling that they need a crystal ball to make the right decisions. Using either a disclaimer or the so-called Clayton election as part of their estate plan can allow at least some hindsight and, consequently, peace of mind.
Marital Deduction Planning and Marital Share Funding Formulas
Before diving into some of the particulars of using a disclaimer and the Clayton election, let us first lay some conceptual groundwork. The main objective of using a marital funding formula in estate tax planning is to take advantage of both (1) the estate tax marital deduction and (2) the estate tax exemption to eliminate the federal estate tax due at the first spouse's death and to reduce or eliminate federal estate tax due at the surviving spouse's death.
What is the marital deduction? In general, as long as they meet the requirements under federal estate tax law, transfers from a decedent spouse to a surviving spouse (provided the surviving spouse is a US citizen) are excluded from the decedent spouse's estate and are not subject to estate taxes at the first spouse's death. This is the unlimited estate tax marital deduction. The unlimited estate tax marital deduction essentially postpones the payment of any estate taxes until after the second spouse's death.
The general concept of the estate tax exemption is that, if the value of your estate is less than the exemption amount, no federal estate tax is due. The 2022 exemption amount for an individual is $12.06 million. Under current law, the exemption amount will be reduced to $5 million (adjusted for inflation) on January 1, 2026. Currently, a 40% tax is imposed on the estate to the extent that its value exceeds the exemption amount.
Marital share funding formulas use both concepts to eliminate federal estate tax to the greatest extent possible. In essence, because the unlimited estate tax marital deduction allows estate tax liability to be postponed until the second spouse's death, the first decedent spouse's estate plan should use a formula to divide the estate into two shares: (1) the marital share, which is the part of the decedent spouse's estate that passes to the surviving spouse in a form that qualifies for the unlimited estate tax marital deduction, and (2) the nonmarital share, which is the part of the decedent spouse's estate that does not qualify for the unlimited marital deduction but is instead sheltered by the decedent spouse's remaining estate tax exemption amount.
Example without a marital share funding formula. Bill and his wife, Cindy, each own half of their $25 million estate. Bill dies in 2022, when the estate tax exemption amount is $12.06 million. Cindy dies in 2026, when the estate tax exemption amount is only $5 million, the inflation-adjusted amount then in effect. Their estate plan leaves the first decedent's estate to the surviving spouse with everything going to their children at the surviving spouse's death.
When Bill dies in 2022, his $12.5 million portion of the estate passes to Cindy estate-tax free under the unlimited estate tax marital deduction. Because all of Bill's $12.5 million passes to Cindy under the marital deduction, when Cindy dies in 2026, the applicable $5 million exemption amount will only protect $5 million of the $25 million estate. Applying a 40% estate tax rate, Cindy's estate would owe $8 million in estate tax.
Example with a marital share funding formula. The facts are the same as in the above example, except that Bill and Cindy's estate plan uses a marital funding formula that divides Bill's estate into marital and nonmarital shares. At Bill's death, $12.06 million is apportioned in trust to the nonmarital share, using all of Bill's estate tax exemption amount, and the remaining $440,000 is apportioned to the marital share. When Cindy dies in 2026, her estate will be worth $12,940,000, consisting of her $12.5 million portion of the estate and the $440,000 apportioned to the marital share. Cindy's $5 million estate tax exemption amount in 2026 will protect $5 million of Cindy's $12.94 million estate. Applying a 40% estate tax rate, Cindy's estate would owe $3,176,000 in estate tax.
By using a marital share funding formula as part of their estate tax planning, Bill and Cindy can prevent their heirs (their children) from having to pay $4,824,000 in estate taxes.
There are numerous different ways to divide a couple's trust property into marital and nonmarital shares upon the first spouse's death, but the disclaimer option gives the surviving spouse the most flexibility. Using the disclaimer option, the trustee or executor distributes all the decedent spouse's trust property to the marital share. The surviving spouse may then exercise a qualified disclaimer (refusal to take ownership of money or property left to them by their deceased spouse) under Internal Revenue Code section 2518, and the trustee distributes any property disclaimed by the surviving spouse to the nonmarital share, which can be either held in trust for the benefit of the surviving spouse (and other beneficiaries if desired) or otherwise administered under the trust agreement's residuary provisions.
With the disclaimer option, the surviving spouse can choose to give any amount or property they wish to the nonmarital share, depending on the estate tax law in effect at the time of the first spouse's death, the value of the decedent spouse's estate, and the surviving spouse's financial needs.
The Clayton election, named after the court case Estate of Clayton, Jr. v. Commissioner, is another formula used to divide a couple's trust property into marital and nonmarital shares. It also provides maximum flexibility to engage in marital deduction planning after the first spouse's death. The way the Clayton election works is almost the opposite of the disclaimer option. Instead of distributing all the decedent spouse's trust property to the marital share, the trustee distributes it to the nonmarital share. The trustee may then list any property on Schedule M—Bequests, etc., to Surviving Spouse (Marital Deduction) of the decedent spouse's IRS Form 706 (the federal estate tax return) to allocate it to the marital share instead.
An advantage of the Clayton election, in contrast to the disclaimer option, is that its technical requirements and timelines are less rigid. While a disclaimer must be made within nine months after the first spouse's death, a Form 706 is not due until up to fifteen months (or possibly twenty-four months if the executor is not required to file an estate tax return but files to elect portability) after the first spouse's death, allowing more time to grieve and for making a less emotion-driven decision. Another advantage of the Clayton election is that it allows someone other than the surviving spouse to objectively decide what property should be apportioned to the marital and nonmarital shares. In addition, because a Form 706 must be filed when using the Clayton election option, there is the opportunity to claim for future use any unused amount of the decedent spouse's estate tax exemption. Finally, because the Clayton election sends the decedent spouse's property into a nonmarital share trust by default, the surviving spouse automatically receives those accounts and property in a form that offers a degree of creditor protection.
Whether to use a marital formula in your estate plan, and which marital formula to use, requires considerable analysis of your estate, your goals, and the law. Contact us to put in place or review your plan to ensure that it will meet all your goals, including deferring, minimizing, or eliminating the estate tax that your heirs will pay.
 Estate of Clayton, Jr. v. Comm'r, 976 F.2d 1486 (1992).